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A catastrophe that will cripple Italy

Published in Newsroom.co.nz (Wellington), 10 March 2020

To start with a disclaimer, I am not a medical expert. I have no degree in epidemiology, nor can I claim any expertise in public health management.

In these difficult times, it is perhaps useful to lay one’s qualifications on the table. There is too much misinformation about the medical aspects of the virus out there. Worse than that, when even the experts contradict each other, what chance would laypeople have to understand what is happening?

That said, there is one aspect of the crisis which relates to my expertise as a commentator on Europe. And that aspect, frankly, scares the hell out of me: It is what the virus does to Italy – and by proxy to the eurozone.

I had been thinking about this column on Italy for a few days and been wondering how to explain the drama to a New Zealand audience.

After the Italian government’s extraordinary decision to lockdown an area of 16 million people, I do not have to do that anymore. It makes it plain to see how high the stakes now are for Italy.

For decades, and indeed for as long as I can remember, Italy has been a country flirting with disaster. But this time, it is no longer a flirt. Italy is fighting for its survival.

I write this as a lifelong Italophile who spent many a holiday in the bel paese and who enjoys Italian food, wine, music and language. It gives me precisely zero pleasure to write anything negative about the country. Vi prego di perdonarmi, amici italiani.

The tragedy of Italian politics is only rivalled by the tragedy of the Italian economy. Of all the countries of the eurozone, there is no other which has suffered as much as the result of having adopted the common European currency.

Italy’s business model prior to the Euro had depended on constant devaluations of its old currency, the Lira. Once that safety valve was removed, Italy would have had to increase its productivity in line with its more competitive European neighbours. It did not. Instead, it enjoyed the boost of lower interest rates that it was used to and gradually eroded its competitiveness.

When the euro crisis struck in the wake of the Global Financial Crisis, Italy was one of the hardest hit countries in Europe. Indeed, it never properly recovered from that crisis. Per capita (and in constant prices), GDP is still lower than it was in 2011. Industrial output collapsed at that time and never returned to its previous levels.

On top of the problems in Italy’s real economy, there has long been a banking crisis. It is a banking crisis that has been simmering under the surface, mainly because the European Central Bank kept it there.

For the past decade, the ECB introduced a range of programmes with the more-or-less explicit aim of stabilising the Italian banking system. Banks were enabled to access cheap, fresh money from the ECB so they could purchase Italian government bonds and pocket the interest rate difference. That way, the ECB kept both the Italian banks and the Italian government afloat. Only every now and then were these policies not enough and Italian banks had to be bailed out like Banca Monte dei Paschi or Banca Popolare di Bari.

The Italian government certainly benefited from the implicit ECB support. It is one of the most indebted governments in the world. Thanks to the ECB’s help, 10-year government bonds currently trade around 1 percent and thus much lower than a decade ago when they peaked at more than 7 percent. Even so, Italy’s debt-to-GDP ratio kept going up and has hovered around 135 percent since 2015.

Politically, it has been a turbulent time for Italy as well. After the wasted Berlusconi years, the EU interfered directly with Italian politics during the GFC and even installed a new Prime Minister by exercising pressure. Ever since, the Italian political system has been characterised by the rise of populism, both from the left and the right. Only very recently, after the exit of the Lega party from government, did the country see a return to a more moderate and conventional form of government.

So, Italy has long been a troubled place on many fronts. Even that is an understatement. We haven’t even mentioned Italy’s demography. Or migration. Or corruption.

But all that was before the coronavirus hit. And the situation now is worse. Much worse.

Despite Italy’s many, many problems, the country could always rely on its inherent appeal. There is only one David – and he stands in the Galleria dell’Accademia in Florence. There is only one Venice in the world. There is no equivalent of Rome anywhere else.

No wonder that tourism had become one of Italy’s most important industries. It was practically the only industry still growing and accounted for about one seventh of Italian GDP. Just for comparison, agriculture accounts for not even half that in New Zealand.

Even before the lockdown was announced on Sunday, there were forecasts for the Italian tourism sector to collapse by several billion Euros and tens of millions of tourists. These forecasts can now be corrected: Tourism is now likely to collapse completely this year.

A few days ago, I saw an economic modelling exercise coming out of the Australian National University. Under a worst-case scenario, it had Italian GDP go down by 8 percent this year. Well, since tourism alone accounts for 14 percent of GDP already, how realistic is that?

But that is just the beginning. Not just that GDP will collapse. Government spending will necessarily increase as a result of the crisis. For 2020, Italy had originally projected a deficit of just above 2 percent of GDP (after much haggling with the EU Commission). Well, forget that now. Indeed, insert your own number because no-one can honestly estimate what government response the coronavirus will trigger.

If we are thus looking at Italy’s public finances, we will see both a numerator and a denominator effect. As GDP will shrink dramatically, the denominator of Italy’s debt ratio will go down. At the same time, new debt-financed spending will push the debt numerator up.

I cannot forecast this, and I doubt anyone else could right now. But it is plausible that by the end of this year we will see debt-to-GDP ratios of 150 percent or more for Italy.

The debt ratio would be bad enough. However, it gets worse. Last year, the Banca d’Italia estimated in a research paper that around 7-8 percent of Italian companies are ‘zombie firms’. These firms are teetering on bankruptcy but are kept alive by low interest rates.

Now imagine what a severe Italian recession would do to these zombie firms. And then imagine what that would do to those Italian banks that gave credit to these zombies.

It is not hard to see where this would leave Italy: It would be a crippled country with one of its main sectors, tourism, effectively shut down, its government over-indebted, its banking system collapsing.

In this scenario, which soon may no longer be a scenario but the cold reality, Italy would be bankrupt. It would be a country just as Greece was a decade ago. Except it is a country several times larger than Greece. And except those other European countries that would need to bail out Italy will be busy dealing with their own coronavirus casualties.
To say it clearly, Italy is too big to fail – in ordinary times. But it is definitely too big to be bailed out – in extraordinary times.

If Italy fails – and there is a temptation to write ‘When’ instead of ‘If’ – it will be a catastrophe not just for Italy. It will be the end of the Euro as Europe’s currency. It will be the return of the euro crisis on steroids.

I have been covering the euro crisis for a decade now for various publications. But I have never seen a situation as dramatic as Italy’s today. The only reason why you may not have read about the new coronavirus-induced Italian euro crisis just yet is that there are so many other coronavirus-induced crises around.

As for my Italian friends, I am afraid I have to finish with a quote from your national poet, Dante Alighieri: Lasciate ogni speranza voi ch′entrate. (Abandon hope, all ye who enter). This will not end well.

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